the concern regarding the correction also grows. One cannot expect
P/E to rise forever. The prices are bound to revert to their equilibrium level. Therefore, from the
stocks with high P/E ratios, we would expect price declines or modest increase in the price in the
future. But as per efficient market hypothesis, stock prices will not show any trend as prices follow a
random walk.
Figure 1 shows the historical P/E ratios of the S&P BSE SENSEX, S&P BSE 500, S&P BSE MID
CAP and S&P BSE SMALL CAP. As per the Figure, all four indexes appear to exhibit mean reversion
behaviour.
Tables 1A and 1B show the results of regression model estimated in the study. It can be seen from the
Tables that subsequent price is positively associated with P/E ratio, whereas subsequent yield is negatively
associated with the ratio, which means subsequent price increases with the increase in P/E ratio whereas
subsequent yield decreases with the increase in the ratio. The results further support mean reversion
theory. In order to check for autocorrelation and heteroscedasticity, Durbin–Watson statistics and
Breusch–Pagan/Cook–Weisberg test are used.